Organisation of Indian Financial System B Com Notes | EduRev

Indian Financial System

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The Organisation of the Financial System in India

The Indian financial system is broadly classified into two broad groups: i) Organised sector and (ii) unorganised sector. "The financial system is also divided into users of financial services and providers. Financial institutions sell their services to households, businesses and government. They are the users of the financial services. The boundaries between these sectors are not always clear cut. In the case of providers of financial services, although financial systems differ from country to country, there are many similarities.

  1. Central bank
  2. Banks
  3. Financial institutions
  4. Money and capital markets and
  5. Informal financial enterprises.

i) Organised Indian Financial System The organised financial system comprises of an impressive network of banks, other financial and investment institutions and a range of financial instruments, which together function in fairly developed capital and money markets. Short-term funds are mainly provided by the commercial and cooperative banking structure. Nine-tenth of such banking business is managed by twenty-eight leading banks which are in the public sector. In addition to commercial banks, there is the network of cooperative banks and land development banks at state, district and block levels. With around two-third share in the total assets in the financial system, banks play an important role. Of late, Indian banks have also diversified into areas such as merchant banking, mutual funds, leasing and factoring.

The organised financial system comprises the following sub-systems:

1. Banking system

2. Cooperative system

3. Development Banking system

(i) Public sector

(ii) Private sector

4. Money markets and

5. Financial companies/institutions. Over the years, the structure of financial institutions in India has developed and become broad based. The system has developed in three areas - state, cooperative and private. Rural and urban areas are well served by the cooperative sector as well as by corporate bodies with national status. There are more than 4,58,782 institutions channellising credit into the various areas of the economy.

ii) Unorganised Financial System

On the other hand, the unorganised financial system comprises of relatively less controlled moneylenders, indigenous bankers, lending pawn brokers, landlords, traders etc. This part of the financial system is not directly amenable to control by the Reserve Bank of India (RBI). There are a host of financial companies, investment companies, chit funds etc., which are also not regulated by the RBI or the government in a systematic manner.

However, they are also governed by rules and regulations and are, therefore within the orbit of the monetary authorities.

Indigenous Banking in India

At independence, India had an indigenous banking system with a centuries-old tradition. This system had developed the hundi, a financial instrument still in use that is similar to the commercial bill of Western Europe. Hundi were used to finance local trade as well as trade between port towns and inland centers of production. They were often discounted by banks, especially if they were endorsed by indigenous bankers. Indigenous bankers combined banking with other activities, much as the goldsmiths, merchants, and shippers of eighteenth and nineteenthcentury Europe had done. They usually belonged to certain castes or communities, such as the Multanis, Marwaris and Chettiars, and they differed in the extent to which they relied on their own resources, rather than deposits and other funds for their lending. Indigenous bankers often endorsed hundis issued by traders and sometimes provided personal guarantees for loans from commercial banks. Such bankers were collectively known as Shroffs, a term that probably originally referred to money changers but over time came to refer to the more sophisticated and influential indigenous bankers. The main moneylenders were the Sowkars (who lent to farmers from their own resources or funds borrowed from the Chettiars and other indigenous bankers) and the Pathans (who lent mainly to poor people and often resorted to intimidation to ensure repayment).

Indigenous banking was based on an elaborate and extensive network of personal relations that overcame the problems of dealing with a large number of customers. Brokers were used for making introductions and vouching for the creditworthiness of individual borrowers but did not offer personal guarantees. Some brokers specialized in introducing indigenous bankers to commercial banks, while others brought together traders and indigenous bankers.

Rural Financial System.

Rural financial system has been evolved over a period of time from the year 1904, when the first Primary Agricultural Credit Society was organized, by accepting and implementing important recommendations of expert committees appointed by the Government of India/RBI from time to time. During the pre-reform period, more particularly, after the advent of the scientific and technological revolution in the sphere of agriculture, the Government of India and the RBI have evolved several new concepts, innovations and novel approaches, which, the Rural Financial Institutions (RFls) have responded very favorably by implementing them

The Banking System

The structure of the baking system is determined by two basic factors – economic and legal. The Development of the economy and the spread of banking habit calls for increasing banking services. The demand for these banking services affects the banks' structure and organisation. National objectives and aspirations result in government regulations, which have a profound influence on‟ the banking structure. These regulations are basically of two types. First, regulations which result in the formation of new banks to meet the specific needs of a group of economic activities. Secondly, legislation that affects the structure by means of nationalisation, mergers or liquidation.

RBI

The Reserve Bank of India as the central bank of the country, is at the head of this group. Commercial banks themselves may be divided into two groups, the scheduled and the non scheduled.

The commercial banking system may be distinguished into:

A. Public Sector Banks

Organisation of Indian Financial System B Com Notes | EduRev

Organisation of Indian Financial System B Com Notes | EduRev

Organisation of Indian Financial System B Com Notes | EduRev

B. Private Sector Banks

i) Other Private Banks;

ii) New sophisticated Private Banks;

iii) Cooperative Banks included in the second schedule;

iv) Foreign banks in India, representative offices, and

v) One non-scheduled banks

Cooperative Sector

The cooperative banking sector has been developed in the country to supplant the village moneylender, the predominant source of rural finance, as the terms on which he made finance available have generally been usurious and detrimental to the development of Indian agriculture. Although the sector receives concessional finance from the Reserve Bank, it is governed by the state legislation. From the point of view of the money market, it may be said to lie between the organized and the unorganised markets

Primary cooperative Credit Societies

The primary cooperative credit society is an association of borrowers and non-borrowers residing in a particular locality. The funds of the society are derived from the share capital and deposits of members and loans from Central Co-operative banks. The borrowing power of the members as well as of the society is fixed. The loans are given to members for the purchase of cattle, fodder, fertilizers, pesticides, implements etc.

Central Co-operative Banks

These are the federations of primary credit societies in a district. These banks finance member societies within the limits of the borrowing capacity of societies. They also conduct all the business of a joint-stock bank.

State Co-operative Banks

The State Cooperative Bank is a federation of Central cooperative banks and acts as a watchdog of the cooperative banking structure in the State. Its funds are obtained from share capital, deposits, loans and overdrafts from the Reserve Bank of India. The State Co-operative Banks lend money to central cooperative banks and primary societies and not directly to farmers.

Land Development Banks

The Land Development Banks, which are organized in three tiers, namely, State, Central and Primary level, meet the long term credit requirements of farmers for developmental purposes, viz, purchase of equipment like pump sets, tractors and other machineries, reclamation of land, fencing, digging up new wells and repairs of old wells etc. Land Development Banks are cooperative institutions and they grant loans on the security of mortgage of immovable property of the farmers.

Money Market

Money market is concerned with the supply and the demand for investible funds. Essentially, it is a reservoir of short-term funds. Money market provides a mechanism by which short-term funds are lent out and borrowed; it is through this market that a large part of the financial transactions of a country are cleared. It is place where a bid is made for short-term investible funds at the disposal of financial and other institutions by borrowers comprising institutions, individuals and the Government itself.

Thus, money market covers money, and financial assets which are close substitutes for money. The money market is generally expected to perform following three broad functions:2

(i) To provide an equilibrating mechanism to even out demand for and supply of short term funds.

(ii) To provide a focal point for Central bank intervention for influencing liquidity and general level of interest rates in the economy.

(iii) To provide reasonable access to providers and users of short-term funds to fulfill their borrowing and investment requirements at an efficient market clearing price.

Capital Market

The capital market is the place where the medium-term and long-term financial needs of business and other undertakings are met by financial institutions which supply medium and long-term resources to borrowers. These institutions may further be classified into investing institutions and development banks on the basis of the nature of their activities and the financial mechanism adopted by them. Investing institutions comprise those financial institutions which garner the savings of the people by offering their own shares and stocks, and which provide long-term funds, especially in the form of direct investment in securities and underwriting capital issues of business enterprises. These institutions include investment banks, merchant banks, investment companies and the mutual funds and insurance companies. Development banks include those financial institutions which provide the sinews of development, i.e. capital, enterprise and know-how, to business enterprises so as to foster industrial growth.

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